Why The Crypto Market Has Lagged In 2018

The cryptocurrency shakeout is well upon us. The crypto market has crashed spectacularly from its January highs, managing to retain just a quarter of its peak value. Looking at the crypto global charts might lead you to believe that this is a zero-sum game since we are back exactly where we were before the crazy rally.

(Click to enlarge)

Source: CoinMarketCap

But it’s important not to lose perspective when looking at this market. Cryptocurrencies are not a zero-sum game. Even at its peak, the crypto market represented less than one percent of global GDP. In sharp contrast, the national value of credit default swaps exceeded 100 percent just prior to the financial crisis.

Here’s a rundown of the key reasons why the crypto market has come unstuck in 2018:

Despite recent reports about fresh capital inflows from hedge funds and VCs, institutional ownership still makes up a miniscule fraction of the entire market compared with other traditional financial markets.

Given the highly fragmented nature of the market and the fact that not too many analysts keep tabs on crypto, it’s difficult to come up with estimates of how much digital assets are in the hands of institutions. We can, however, look at bitcoin stocks, futures and hedge fund ownership as good proxies.

Currently, there are no existing pure-play bitcoin or altcoin stocks. The closest thing we have to that is the Bitcoin Investment Trust (NASDAQOTH:GBTC) by Grayscale Investments. GBTC currently has a market cap of $1.54B.

In June, Grayscale revealed that it had received $248.39 million in new crypto investments since the beginning of the year of which 56 percent had come from institutional investors. That proves that institutional investors are warming up to crypto assets. But even assuming the same ratio holds for the company’s past investments would mean that GBTC worth only ~$860M is in the hands of institutions.

In April, CCN reported record daily bitcoin futures volume of $670M. Throw in a 44-percent margin requirement (margin requirement for bitcoin futures is extraordinarily high due to the currency’s volatility) and you end up with total futures contracts worth $965M.

It’s a well-known fact that bitcoin futures are almost the preserve of institutional investors. Further, there are 466 crypto funds holding $7.1 billion in crypto assets, according to Crypto Fund Research. The three asset classes add up to ~$9B, which works out to just 4.3 percent institutional ownership for the crypto industry.

In other words, retail investors control about 95 percent of cryptos. That’s nearly triple the 33-percent retail ownership of U.S. equities. Institutions (mutual funds, pension & government retirement funds and hedge funds), ETFs and international investors control ~60 percent of U.S. stocks.

Retail investors tend to be fickle in nature, with get-rich-quick retail inflows accounting for a 300-percent climb during last year’s rally. The reverse has been happening for much of this year. High retail ownership might be great during a hype cycle, but is equally bad when FUD (Fear, Uncertainty and Doubt) strikes.

Crypto Fees and ICOs

But it wouldn’t be fair to solely blame retail investors for a languid crypto market. There are other more subtle factors also at play, too.

First off, the high fees earned by crypto exchanges during an up-leg can later work against the market. For instance Binance, the world’s largest crypto exchange, is on track to realize earnings of $1 billion. The commission charged by these exchanges is mostly in the form of cryptocurrencies. This can create a fair amount of selling pressure when they start converting their crypto to fiat.

The same logic applies to ICOs, but to an even greater degree.

2018 has been a boffo year for ICOs, with more than $12 billion raised during the first half of the year. A big number have been demanding ETH in exchange for their tokens. There’s growing evidence that many of these startups have started to liquidate their ETH holdings, thus creating further downward pressure on prices across the board.

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